Changes in the regulation and treatment of cap breaches have presented a potential opportunity for trustees to get more money into their SMSFs. Zoe Fielding reports.
The favourable tax treatment of superannuation savings makes it appealing for consumers to maximise the amount of assets they hold in that environment. Income generated on assets held in super is taxed at only 15 per cent while the fund is in its accumulation phase, while earnings accrued during the pension phase are tax free.
These tax sweeteners are used to encourage individuals to save for the future, which the government hopes will relieve pressure on the pension system down the track. But it’s a fine balance between future savings and the immediate cost to the federal budget of the tax concessions.
To manage that balance, the amount people can contribute to their super funds each year is capped. These caps have been set at a constant level for the past five years since the government paused their indexation due to budget constraints.
The contribution caps will be lifted in the 2015 financial year and annual indexation will resume with the thresholds to be raised each year in line with average weekly ordinary time earnings, rounded down to the nearest $5000.
From 1 July 2014, people aged under 49 will be able to add $30,000 in pre-tax amounts, such as employer superannuation guarantee payments and salary-sacrificed sums, to their super funds, up from $25,000 the year before. These are known as concessional contributions.
Special privileges given to people aged 59 and over in the 2014 financial year to add up to $35,000 in pre-tax amounts to their super funds have been extended to those aged 49 and over on 30 June for the 2014/15 tax year. The advantage of that temporary limit will disappear when indexation allows the general caps to catch up to the $35,000 amount.
Non-concessional contribution limits, which are set at six times the general concessional contribution cap, will also increase in 2014/15 to $180,000 from $150,000, where they have been since mid-2007.
It’s a development that has been widely welcomed by industry and consumers alike, although many in the financial services industry argue the limits are still too low.
The Institute of Public Accountants in its pre-budget submission called for the caps to be lifted to $50,000 for those aged between 50 and 60, and to $75,000 for those aged over 60.
HLB Mann Judd director of wealth management Andrew Yee welcomes the resumption of contribution cap indexation, but says the increase is probably inadequate.
“At least it’s an increase and when you combine that with the non-concessional cap going up to $180,000 per year from $150,000, you can fit quite a bit more into super,” Yee says.
NowInfinity principal Grant Abbott says the uplift will make a significant difference to fund members, although he would also prefer the limits to be higher again.
Abbott points out the increase will allow people to make $90,000 of extra non-concessional contributions in a particular year under the bring-forward rules, which allow people under 65 to add three years’ worth of non-concessional contributions to their fund in one year.
There are disincentives to encourage people to stick to the contribution limits.
Up until 30 June 2013, people who put more than the allowed amount into their funds were heavily penalised. Excess contributions were taxed at an elevated rate, which could lead to liabilities of up to 93.5 per cent in tax on the contributed sum. There were few mechanisms for removing sums inadvertently placed into superannuation in breach of the caps.
The harsh penalties were relaxed last year following extensive industry lobbying.
From 1 July 2013, people who add too much to super through concessional contributions no longer have to pay a penalty tax. Instead, the excess amount is included in their assessable income for that financial year and taxed at their marginal tax rate.
The tax rate that applies to excess concessional contributions is a significant change, Macquarie Bank executive director David Shirlow says.
“For previous years, it has always been the top rate regardless of the individual’s tax rate. From this year, if someone is on a tax rate lower than that, their own tax rate applies,” Shirlow says.
Members who have contributed too much also have the option of withdrawing up to 85 per cent of the excess amount after the fund has paid its 15 per cent contributions tax.
The 15 per cent tax is offset against the amount owed at the member’s marginal tax rate. For example, if the member’s marginal tax rate is 32.5 per cent (or 34 per cent including the Medicare levy), the fund would pay 15 per cent on the excess contribution and the member would pay 19 per cent tax on the 85 per cent that was withdrawn from the fund.
Members also have the option of leaving the excess amount inside the fund and paying the tax from savings held outside of super. Shirlow says there can be an advantage to doing this, as subsequent earnings on investments inside the fund are taxed at a rate lower than they would be outside super.
One point to note, he says, is that excess concessional contributions left inside the fund count towards the non-concessional contributions cap, while amounts that are withdrawn do not.
“That’s not going to be a problem for most people, but when it will be is if they have very large excess concessional contributions or if they have already put in non-concessional contributions,” he says.
There are still substantial penalties for exceeding both the concessional and non-concessional contribution caps. Shirlow says it would be wise to take a refund for the excess contribution if a member was in danger of breaching all of the caps that apply. “Then the whole contribution would be ignored for the purposes of the non-concessional cap,” he adds.
Excess concessional contributions are added to the fund’s taxable component, which has consequences for people who plan to withdraw superannuation benefits before they turn 60, and for estate planning if death benefits will be passed to adult children.
They are also counted towards income tests for payments such as family tax benefits and spouse contribution rebates, regardless of whether they are withdrawn from the fund.
In addition to tax, an excess concessional contributions charge is levied on tax due on amounts contributed over the cap. The Australian Taxation Office (ATO) says this recognises the tax is collected later than normal income tax.
Shirlow says the catch with this charge is that it applies from the start of the tax year when the member made the contribution through to the time when the tax liability is due to be paid.
“It runs from the start of the year of contributions, not when the excess contribution was made,” he says.
The interest charge is based on the monthly average yield of a 90-day Bank Accepted Bill published by the Reserve Bank of Australia. To that amount, the ATO adds three percentage points. The rate for the December quarter of 2013 was 5.6 per cent for the year, or 0.01534246 per cent a day.
The rules aim to ensure individuals are taxed on excess concessional contributions in the same way as if they had received the money as salary or wages and then made a non-concessional contribution to their super funds. On the surface, it seems the incoming regime simply neutralises the effect of excess concessional contributions made to the fund.
But Abbott says if you dig deeper, the new regime opens up strategies that can benefit clients, particularly those with SMSFs.
“If you look at it without a timescale or strategy, you are paying the same tax or more, but what it means is that you’re out of the pay-as-you-go tax system,” he says.
SMSF members pay tax at the end of the financial year after they have been audited. By breaching the caps and shifting the money into superannuation, SMSF members can defer paying tax.
“There’s a time value of money there if you put your money into super on July 1, you’re not going to have to pay tax on it for up to 18 months,” Abbott says.
The excess concessional contributions charge also makes timing important. Members who breach the limit on the last day of the tax year still have the interest charge calculated over the entire financial year.
“Cash flow and budgeting is really the king. The sooner you get those contributions in, the more value you get out of it,” Abbott says.
A member might be able to make a $100,000 pre-tax contribution to their SMSF on 1 July. Despite the fact the amount is $70,000 more than allowed under the 2014/15 concessional contribution caps, and therefore an excess concessional contribution, the member would have the full $100,000 working for them from day one.
If they had taken that amount outside of super, the amount available for investment would immediately be reduced by their marginal tax rate.
The member will eventually have to pay tax on the contribution and an excess concessional contribution charge on the tax liability, but with the right investments, the earnings would outweigh the costs, Abbott says.
Anything the member can do within the fund to reduce the 15 per cent tax that the super fund has to pay – such as paying insurance premiums, receiving franking credits on shares or negatively gearing a property – can increase the benefit, he says.
The rules have been enshrined in legislation and he says it won’t be possible for the tax commissioner to shut the strategy down, although he admits it has its practical limits.
“The money has to be actively employed within the superannuation environment to make it worthwhile,” he says.
There would be little to no advantage to holding the money in cash as there are no tax deductions available and the income generated on the savings would be less than the excess concessional contributions interest charge.
There could be advantages, however, to investing in shares with fully franked dividends that offset the tax liability and could produce higher income and capital gains. Investment property with its capital depreciation and allowances could help reduce the tax bill, while long-term capital gains could outweigh the cost of the interest charge.
However, some advisers are reluctant to encourage clients to intentionally breach the caps.
Yee says it’s difficult to promote strategies that aim to break the rules as many clients are conservative and would prefer to avoid a potential confrontation with the tax office.
“Those strategies probably add marginal value to the client and the downside is that they could backfire,” Yee says.
“Things could go wrong and the ATO may not see it the same way as you and that could result in having to do some explaining to the client and the regulator, marginalising the value it adds.”
He says it’s great the harsh penalties for inadvertently breaching the caps have been removed, “but we don’t tell the clients to deliberately go over the caps”.